Comment | The SEC’s power to recover illegal gains is limited. Can cryptocurrency startups benefit from it?

Comment | The SEC’s power to recover illegal gains is limited. Can cryptocurrency startups benefit from it?
The supervision of the U.S. Securities and Exchange Commission (SEC) has always been a nightmare for cryptocurrency startups. The uncertainty of supervision has made ICO projects in the United States extremely difficult. At the beginning of this year, the Telegram project, which had been struggling repeatedly, was finally forced to run aground. Several ICO projects that were considered to have great potential were stillborn because they were identified by the SEC as "issuing unregistered securities." In judicial practice, most courts have affirmed the SEC's regulatory thinking and have a default attitude towards its punishment measures. However, recently, the U.S. Supreme Court upheld the SEC's power to recover illegal gains in a ruling, but made clear restrictions on the scope of recovery of illegal gains.

The scope of the SEC's recovery of illegal gains should be limited to the net profit involved in the case

In 2016, Charles Liu and Xin Wang raised $27 million in investment from 50 Chinese compatriots on the pretext of building a cancer medical center in the United States. However, 18 months after the funds were raised, the cancer medical center had not started construction, and the couple transferred all the raised funds to their corporate and personal accounts in China. In view of the couple's fraudulent behavior, the SEC filed a civil lawsuit against them. The federal district judge and the Ninth Circuit Court of Appeals agreed with the SEC's opinion, maintaining the $8 million civil penalty and requiring the return of the entire $27 million.
The couple was dissatisfied with the verdict and appealed to the U.S. Supreme Court. The appeal was based on two main points:

First, the SEC’s power to recover illegal gains is questioned.

Although Congress authorized fines for stock fraud, it did not give the SEC the power to recover funds.

Second, the amount of recovery was questioned.

Most of the $27 million was spent on acquiring the property and approving the center, from which they made a net profit of only $8 million.

The U.S. Supreme Court ultimately ruled 8 to 1 in favor of the SEC's recovery decision, but limited the SEC's recovery of illegal gains without considering and deducting legitimate business expenses, and ruled that the scope of recovery should not exceed the net profit of the illegal activities.

Behind the ruling

In fact, the recovery of illegal gains has become a common means in civil cases, and the same punishment measures have been taken in the past in the supervision of ICOs of cryptocurrency start-ups. However, US federal law and Congress do not explicitly grant the SEC the power to recover illegal gains, so many people criticize this punitive measure as a tool for the SEC to abuse its regulatory power.
Justice Sonia Sotomayor said that seeking damages is not simply to deprive the defendant of his illegal gains, but the main purpose is to compensate the victims. It can be seen that the judge affirmed the SEC's power to recover illegal gains for the purpose of protecting investors. However, when the illegal gains are difficult to redistribute to the victims, whether the SEC has the right to deposit the illegal gains into the national treasury is still worth discussing.

Some securities law experts viewed the ruling as a major setback for the government.

Nick Morgan, a former SEC attorney, said:

“This decision upends decades of SEC practice and limits the SEC’s ability to pursue disgorgement in federal court. In particular, the SEC will no longer be able to require defendants to pay directly to the U.S. Treasury instead of victims, to pay profits received by others, or to pay expenses lawfully incurred as a result of obtaining funds in violation of federal security laws.”
It should be noted that the Sarbanes-Oxley Act gives judges the power to grant the SEC enforcement authority based on fair considerations:
Judges can grant securities regulators enforcement powers they deem consistent with the principle of equitable relief, and asset recovery is a move traditionally viewed as fair.
Clearly, Justice Sonia Sotomayor's ruling, which was based on the original intention of investor protection, is consistent with the principle of fairness upheld by the Act.

For cryptocurrency startups, although this ruling cannot restrict the SEC from requiring companies to return funds raised through ICOs, it can at least prevent the SEC from pursuing their income beyond profits during the regulatory process, thereby controlling losses within a certain range.

Link to this article: https://www.8btc.com/media/614724
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